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The Federal Reserve concluded a pivotal meeting of its rate-setting body today with a commitment to leave interest rates near zero along with an announcement that later this month, it will start unwinding one one of its biggest and most unprecedented market interventions undertaken in the wake of the pandemic.
Wall Street had been awaiting Fed Chairman Jerome Powell’s remarks about the stubbornly persistent inflation that is beginning to create interest rate anxiety on Wall Street.
In his prepared statement, Powell continued to use the word “transitory” to characterize the inflationary climate, although he also acknowledged that the supply chain disruption had created “sizable price increases” in some parts of the economy.
Market observers had predicted that Powell would revisit how he characterized the current level of inflation, given that the long duration of higher prices seems to stretch the definition of the term. “If this inflation isn’t transitory, what is it?” said Zhiwei Ren, managing director and portfolio manager at Penn Mutual Asset Management.
“I don’t know if the word ‘transitory’ is going to be used as frequently,” said Greg McBride, chief financial analyst at Bankrate. “The Fed has acknowledged this could persist longer and at higher levels than they originally expected,” he said.
Keith Buchanan, portfolio manager at Globalt Investments, said the “more sticky” nature of the current inflation pressures present a challenge Powell needs to address.
Atlanta Fed president Raphael Bostic went even further, calling the word “transitory” a “dirty word” in a virtual speech to the Peterson Institute for International Economics on Tuesday.
Bostic said he expected that the supply chain disruptions driving up prices will linger, saying, “By this definition, then, the forces are not transitory.”
Conversely, since this bout of inflation is supply chain-driven, Powell is likely to maintain the position that it doesn’t represent a long-term threat to economic growth, McBride said.
“Inflation is front and center as an issue and will be for the next six to 12 months, easily, but that alone is not going to dictate Fed action. Economic growth, the labor market and even geopolitical concerns could very likely come into play,” he said.
The backdrop to the conversation around inflation’s staying power is the Fed’s long-awaited taper. Since June 2020, the central bank has been purchasing $120 billion in bonds — $80 billion in Treasuries and $40 billion in mortgage-backed securities — every month to add liquidity and keep the financial system working efficiently. On Wednesday, Powell said that the Fed would begin reducing those purchases by $10 billion and $5 billion, respectively, later this month. The Fed will continue to step down by those increments, though Powell said the bank was “prepared to adjust the pace of purchases if warranted by changes in the economic outlook.”
“This is an important meeting. It’s the Fed meeting we’ve been waiting for since May or June,” said Lawrence Gillum, fixed income strategist for LPL Financial. Market observers expect the tapering to begin either later this month or in December, based on commentary Fed officials started providing this summer.
Although James Bullard, the regional Fed president in St. Louis, recently suggested that tapering could conclude as early as the first quarter of next year, most market participants think it is likelier that the Fed will take a slower pace and wrap up those bond purchases entirely by next June.
“They’ve talked about giving markets advanced notice. This Fed has been very deliberate in their communication strategy,” Gillum said.
Powell has taken pains to assure — and reassure — investors that winding down these monthly purchases is a separate activity and not linked to rate hikes.
But while the Fed has telegraphed its intentions to hold rates near zero until 2023 or late 2022 at the earliest, Wall Street is racing ahead with expectations of more hawkish policy.
“A lot of the questions and concerns has now moved onto when does the rate hike cycle begin,” Buchanan said. “Of course, markets are supposed to be forward-looking. I think the focus will shift to the rate hike cycle and how quickly will that happen.”
Communication is paramount right now. The last thing the Fed wants to give off is a sense of panic.
With a number of inflation metrics remaining sharply elevated, the CME’s FedWatch Tool finds that markets are expecting two rate hikes in 2022 alone.
“I’m going to watch how much he talks about inflation and how much he pushes back on the market expectation,” Ren said.
“I think and expect Chair Powell to talk about how tapering isn’t tightening and there’s no expected time to start hiking interest rates,” Gillum said. He acknowledged the divergence between Fed policy statements and Wall Street sentiment. “They’ve been talking about that for several months now, but it seems like the market isn’t listening,” he said.
Experts said, though, that recent metrics such as GDP growth and job gains coming in lower than expected could give the Fed more justification for holding rates near zero.
“That’s one of the reasons we’re putting off rate hikes. The labor market hasn’t fully recovered yet,” Gillum said.
“The slower growth will actually ease concerns on an ‘overheating’ economy and give support to Chairman Powell’s view that interest rates need to remain at current levels through the latter half of 2022,” said Chris Gaffney, president of world markets at TIAA Bank.
Gaffney added, though, that estimating how persistent inflation will be in the near future is an exercise fraught with the potential for miscalculation, even among policymakers. “Inflation expectations continue to rise across the globe, so investors will be closely watching how central banks’ views on inflation are adjusting to the data,” he said.
Investing experts said the stakes are high for Powell to avoid giving markets the impression that the Fed is pivoting or readjusting its policy framework on the fly. “Communication is paramount right now,” Buchanan said. “The last thing they want to give off is a sense of panic… if they lose their credibility, they lose their effectiveness,” he warned.
“If the Fed does come out more hawkish than markets are expecting, we could see a bout of volatility,” Gillum said. “There’s always that risk of a hawkish upside surprise.”
Martha C. White is an NBC News contributor who writes about business, finance and the economy.
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